Section 12A Of IBC: A Pathway For Regaining Business Control

Introduction

The Insolvency and Bankruptcy Code, 2016 ('IBC') was introduced with a clear purpose to keep the economic machinery running and prevent the wheels of business from grinding to a halt. The IBC, a beacon of hope, aimed to tackle the persistent issue of financially distressed entities by ensuring timely resolution. By prioritizing resolution over liquidation, the IBC was designed to revive the business, safeguard jobs, and protect the interests of creditors, thus preserving the economic value that would otherwise be lost in lengthy legal battles. S. 12A of the IBC, a pivotal provision, plays a crucial role in this framework by allowing the withdrawal of insolvency proceedings post-admission if an amicable settlement can be reached.

This insight critically examines the role of s. 12A under the IBC, the legal framework, and the challenges and criticisms it faces. By analysing key judicial interpretations, we aim to understand how s. 12A of the IBC contributes to the objectives of the IBC. Importantly, we also explore the implications of s. 12A for the future of businesses in India, as this provision significantly impacts the business landscape.

The Legal Framework of S. 12A

i. Initial Challenges and the need for s. 12A

Initially, the IBC did not provide a mechanism for the withdrawal of insolvency applications once admitted, even if all parties involved, i.e., the applicant, the creditors, and the erstwhile management or promoters of the corporate debtor ('CD'), mutually agreed to settle the matter outside the National Company Law Tribunal ('NCLT') or National Company Law Appellate Tribunal ('NCLAT'). This limitation often led to peculiar situations where, despite unanimous consent to resolve the issues privately, the NCLT and NCLAT, bound by the absence of such a provision in the IBC, could not allow the withdrawal of proceedings, even under their inherent powers. This rigid approach was seen as counterproductive, especially in scenarios where a resolution was achievable without further judicial intervention. The need for a provision like s. 12A was acutely felt. One such limitation was faced by the Hon'ble Supreme Court in Utara Foods and Feeds (P) Ltd. v. Mona Pharmachem¹, wherein the Supreme Court exercised its authority under a. 142 of the Constitution of India ('Constitution') to nullify the NCLAT order that had invalidated the settlement between creditors and the corporate debtor. Subsequently, s. 12A was added to the IBC² to address these limitations, allowing the withdrawal of insolvency proceedings if supported by 90% of the committee of creditors ('CoC').

However, in Swiss Ribbons Pvt. Ltd. v. Union of India³, the petitioners challenged the constitutionality of s. 12A granted excessive power to the CoC, potentially allowing decisions to be made at their whims, thus violating a. 14 of the Constitution. However, the Supreme Court upheld its constitutional validity, relying on the Insolvency Law Committee Report⁴, and concluded that the 90% approval threshold by the CoC was reasonable and justified, promoting comprehensive settlements with all creditors.

ii. Procedure for Filing a S. 12A Proposal

The process for a s. 12A Proposal begins with the filing of Form FA under Regulation 30A of the Insolvency and Bankruptcy Board of India (IBBI) (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 ('Regulations') by the applicant who initiated the insolvency proceedings. The resolution professional ('RP') then presents this withdrawal application before the CoC, which deliberates and votes on the proposal. If the requisite majority, i.e. 90%, the application is submitted to the NCLT for final approval. A favourable NCLT order results in the termination of the corporate insolvency resolution process ('CIRP'), effectively restoring control to the CD. In Brilliant Alloys Pvt. Ltd. v. S. Rajagopal⁵, the Supreme Court clarified that s. 12A could be applied even after the issuance of the invitation for expression of interest (EOI), highlighting the provision's flexibility to accommodate settlements at any stage of the CIRP.

Impact and Significance of S. 12A

Before s. 12A was introduced as there was no provision allowing the withdrawal of CIRP once admitted, even when all parties were in agreement. This rigid stance forced CIRP to continue despite a mutual settlement, resulting in extended disputes. Although the contention was somewhat justified that once admitted, the CIRP transcends the interests of the CD and creditors alone, impacting the economy at large, it became increasingly clear that an inflexible process often worked against the broader intent of the IBC: to revive distressed businesses and avoid unnecessary liquidation.

The introduction of s. 12A addressed these challenges. This provision requires the consent of 90% of the CoC. It serves as a lifeline for businesses to regain control and resume normal operations, often through settlements and negotiations that occur outside the strict confines of formal insolvency proceedings. It embodies the spirit of the IBC by ensuring that viable businesses are not prematurely liquidated but are given the opportunity to bounce back and contribute to the economy by facilitating swift and collaborative settlements. S. 12A enhances the efficiency of the IBC, aligning it more closely with its fundamental purpose of fostering economic dynamism.

S. 12A of the IBC as a Tool for Regaining Business Control

S. 12A empowers businesses to negotiate directly with creditors, offering a path to settle disputes without undergoing the full CIRP. This flexibility reduces the financial and operational strain associated with insolvency, including the high costs of resolution and the uncertainty that can destabilize a business. The ability to settle early under s. 12A is particularly advantageous, allowing businesses to maintain operational continuity and preserve value while addressing creditor concerns effectively.

Pros and Cons of S. 12A Proposals

S. 12A of the IBC provides a critical opportunity for businesses to regain control, offering distinct advantages and challenges that shape their impact.

Pros

• Familiar with the business intricacies, promoters are best positioned to drive recovery. Their expertise, experience, and professional networks make them ideal for reviving operations effectively compared to external resolution applicants.
• The CIRP incurs significant costs, including fees for RPs, Insolvency Professional Entities, and legal proceedings. S. 12A proposals can mitigate these ongoing expenses, redirecting resources towards business revitalization.
• Prolonged insolvency processes often lead to asset depreciation, reducing potential returns. Early settlement under s. 12A helps maintain business value and prevents the deterioration associated with extended CIRP.
• Founders bring deep commitment and understanding, viewing the business not just as an asset but as a dynamic entity. This personal investment often leads to a more vigorous and dedicated approach to business recovery.

Cons

• S. 12A allows promoters to regain control, sometimes at the expense of creditors. This can create an imbalance, favouring those who initially led the company into financial distress.
• The misuse of s. 12A proposals can lead to strategic delays, disrupting the timely resolution of insolvency cases and prolonging uncertainty for creditors.
• Settlements under S. 12A are less transparent than the formal CIRP, raising concerns about fairness and equity, particularly for creditors who may feel sidelined in private negotiations.
• There is a risk that the insolvency process may be used as a bargaining chip to force better settlements, reducing the NCLT and IBC forums to negotiation levers rather than genuine resolution mechanisms.

Judicial Interpretations and Key Case Laws

The Supreme Court and NCLAT have consistently sought to strike a balance between upholding the CoC's commercial wisdom and protecting stakeholders' procedural rights. The jurisprudence around s. 12A of the IBC is likely to continue evolving as new challenges and interpretations arise. Still, the foundational principles laid down in the rulings discussed below provide a framework for future cases.

Supreme Court's Rulings

• In Swiss Ribbons Pvt. Ltd. v. Union of India (Supra), the Supreme Court upheld the constitutionality of s. 12A of the IBC, permitting that the 90% approval threshold by the CoC was reasonable and justified to foster genuine settlements and prevent frivolous withdrawals. Furthermore, the Supreme Court clarified that any arbitrary rejection of withdrawal applications by the CoC could be challenged under s. 60 of the IBC before the NCLT, providing a safeguard against misuse. It was clarified that the NCLT could exercise its inherent powers under r. 11 of the NCLT Rules, 2016, to allow withdrawals when the CoC is not constituted at the initial stages. This interpretation supports the flexibility of s. 12A in its early stages and emphasizes the role of the NCLT in ensuring justice.
• In Vallal RCK v. Siva Industries and Holdings Ltd.⁶, the Supreme Court reiterated the principle that while the commercial wisdom of the CoC should generally be given priority, this does not imply absolute immunity from the judicial review. The NCLT retains the authority to intervene in cases where the CoC's decision appears to be arbitrary, unreasonable or malafide. This ruling highlighted the NCLT's commitment to ensure that the resolution process remains fair and just, safeguarding the interest of all stakeholders involved in the insolvency proceedings.

NCLAT's Interpretations

• In Anuj Tejpal v. Rakesh Yadav⁷, the NCLAT highlighted the application of r. 11 of the NCLT and NCLAT Rules, 2016, stating that when a withdrawal application under s. 12A is filed before the formation of the CoC. The RP must present it directly to the NCLT. This interpretation by the NCLAT ensures that genuine settlement offers are not unduly delayed by procedural formalities, thus promoting early resolution and reducing the burden on the insolvency process.
• Recently, in Asha Chopra & Ors. v. Hind Motors India Ltd.⁸, the NCLAT, New Delhi Bench, dealt with the issue of whether s. 12A could be invoked during the liquidation process. The NCLAT ruled that s. 12A applies only during the CIRP and not after the liquidation process. The NCLAT dismissed reliance on precedent in V. Navaneetha Krishnan v. Central Bank of India⁹, which suggested flexibility for s. 12A during liquidation.

Challenges and Criticisms of s. 12A

While S. 12A offers a valuable opportunity for business recovery, it faces several challenges and criticisms that affect its implementation and fairness.

• One major criticism is the composition of the CoC, which is primarily made up of financial creditors ('FCs'). This often sidelines operational creditors ('OC'), who play a crucial role in the company's daily operations. The lack of representation for OCs in the CoC means their interests are frequently ignored in the decision-making process, leading to settlements that disproportionately benefit FCs at the expense of other stakeholders.
• Another significant challenge is the stringent requirement of 90% voting approval by the CoC to withdraw a CIRP under s. 12A. This high threshold is intended to prevent frivolous withdrawals but often proves a significant barrier, especially in cases where even a few dissenting creditors can block a potentially viable settlement. This stringent requirement can impede timely and effective resolutions, prolonging the financial distress of the CD. In Y Shivram Prasad v. S Dhanpal & Ors.¹⁰, the NCLAT, New Delhi, observed that a higher threshold for CoC approval could sometimes act against the IBC's intent, making it challenging to achieve amicable resolutions.
• Another critical issue is the lack of transparency in s. 12A proposals. The negotiations between the erstwhile management/ promoters and creditors often occur behind closed doors, with little to no disclosure of how decisions are made or what terms are agreed upon. This opaque process raises concerns about fairness and accountability, as stakeholders, including OCs and employees, are left uninformed about the reasons behind the decisions.
• Further, complicating the s. 12A process is the absence of clear communication channels and guidelines. Creditors may respond inconsistently to proposals, sometimes without providing any rationale for their decisions. This further opens the pandora of litigation before the NCLTs and delays the settlement process.
• Lastly, there are no standardized procedural norms for pursuing a s. 12A proposal, resulting in varied interpretations and practices across different cases. The absence of defined guidelines means that the CoC's decisions can appear arbitrary, as there is no consistent framework to evaluate the merits of a proposal or ensure that the process is equitable for all parties.

Recommendations

1. Inclusive composition of the CoC: Currently, OCs are largely excluded from the decision-making process, which can lead to inequitable outcomes. Including OCs in the CoC would ensure that their interests are represented and that decisions reflect their perspectives as well.
2. Lowering the voting threshold to 66%: Reducing the threshold to 66% is similar to the voting requirement for approving resolution plans under s. 30 of the IBC would make the withdrawal process more practical and accessible. This would ensure that a substantial majority agrees while preventing a small minority from blocking potentially beneficial settlements.
3. Standardized evaluation criteria for proposals: This would ensure consistency and fairness in decision-making. Criteria could include financial viability, impact on creditors, potential for business revival, and alignment with the broader goals of the IBC. Thus, it guides the CoC in making informed decisions that are transparent and justifiable.
4. Mediation mechanism: Mediators with expertise in insolvency and financial restructuring could help bridge gaps in negotiations, provide impartial guidance, and ensure that settlement is reached fairly and efficiently. Mediation would not only complement the existing legal proceedings but also decrease the burden of the NCLTs.
5. Periodic review and incentivizing timely resolutions: NCLT oversight of the progress and adherence to agreed-upon terms of s. 12A settlements could ensure compliance and accountability. In addition, offering incentives for early settlements, such as reduced penalties or expedited regulatory clearances, could encourage stakeholders to pursue this route proactively.

Conclusion

S. 12A of the IBC is a pivotal provision that enables distressed businesses to regain control through negotiated settlements. Facilitating the withdrawal of CIRP with the consent of the CoC aligns with the IBC's focus on business revival over liquidation. This approach balances creditor interests with those of CD, ensuring viable businesses are preserved. However, challenges remain, such as excluding OCs, high voting thresholds, and lack of transparency, indicating a need for reform. Addressing these issues by including OCs in the CoC, lowering voting thresholds, and introducing clear guidelines and communication protocols can enhance the effectiveness of s. 12A

Overall, s. 12A serves as a crucial tool in India's insolvency framework, bridging formal resolution processes and practical business needs. Refining its implementation will help the IBC sustain economic dynamism, safeguard jobs, and preserve value for all stakeholders, with ongoing adjustments and a commitment to fair and transparent procedures. S. 12A has the potential to significantly contribute to the sustainable recovery of distressed businesses and the broader economy.

Footnotes

1 Utara Foods and Feeds (P) Ltd. v. Mona Pharmachem (2018) 15 SCC 587.

2 The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018.

3 Swiss Ribbons Private Limited and another v. Union of India and others; (2019) 4 Supreme Court Cases 17: 2019 SCC OnLine SC 73.

4 Report of the Insolvency Law Committee, 2018.

5 Brilliant Alloys Private Limited v. S. Rajagopal and other; (2022) 2 Supreme Court Cases 544.

6 Vallal RCK v. Siva Industries and Holdings Limited and others; (2022) 9 Supreme Court Cases 803: (2022) 4 Supreme Court Cases (Civ) 782: 2022 SCC OnLine SC 717.

7 Anuj Tejpal v. Rakesh Yadav and another; 2021 SCC OnLine NCLT 5794.

8 Asha Chopra and others v. M/s Hind Motors India Limited; Company Appeal (AT) (Insolvency) No. 1425 – 1428 of 2024.

9 V Navneetha Krishnan v. Central Bank of India, Coimbatore and another; 2018 SCC OnLine NCLAT 904.

10 Y. Shivram Prasad v. S. Dhanapal & Ors. Company Appeal (AT) (Insolvency) No. 224 of 2018.

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